The ATO frequently re-focuses its attention on claims that investment property owners make for repairs to rental residences that it deems to in fact be “improvements”.

The scenario where investment properties have work done on them often happens shortly after the property is purchased, and has led to the term “initial repair” being commonly used when discussing the tax implications of such property works.

It pays to keep in mind that generally these sorts of costs are on capital account, and therefore not specifically deductible under rules that allow for a particular deduction for repairs and maintenance costs. Instead, a deduction may be claimed for depreciation under the uniform capital allowance provisions or the capital works provisions. Rental property owners get regular ATO attention on “initial repairs”The following scenario, which is borrowed from the ATO, illustrates this:

A taxpayer recently claimed repairs and maintenance for a newly acquired rental property, which was significantly improved upon purchase. The taxpayer provided an invoice from an interior developer for the “refurbishment” of the property.

Further documentation detailed the scope of the refurbishment, which included completely stripping the property and replacing old fixtures and fittings with new. The large repairs and maintenance claim was disallowed because initial repairs and improvements to a property are not deductible.

Some taxpayers have been asked by the ATO to provide evidence that such costs are not initial repairs if they disclose repairs and maintenance costs in their tax return.

The ATO has issued guidance that sets out considerations in deciding whether or not an expense is an “improvement”:

whether or not the thing replaced or renewed was a major and important part of the structure of the property

whether the work performed did more than meet the need for restoration of efficiency of function, bearing in mind that “repair” involves a restoration of a thing to a condition it formerly had without changing its character

whether the thing was replaced with a new and better one, and

whether the new thing has considerable advantages over the old one, including the advantage that it reduces the likelihood of repair bills in the future.

If the answer to some or all of the above considerations is “yes”, then the expenditure would likely be an improvement, and therefore not deductible.

An example from the ATO’s guidance that distinguishes between a repair and improvement is as follows (note that this example would have similar application to rental property owners):

Mary Fabrica owns a factory in which the bitumen floor laid on a gravel base needs repairing. She replaces it with a new floor consisting of an underlay of concrete topped with granolith (a paving stone of crushed granite and cement).

The new floor, from a functional efficiency (rather than an appearance) point of view, is not superior in quality to the old floor. The new floor performs precisely the same function as the old and is no more satisfactory. In fact, the new floor is more expensive to repair than the old.

Because the new floor is not a substantial improvement, it is a repair and its cost is most likely deductible.

Distinguishing between repairs or improvements for your client’s rental property can be tricky, but it is essential to do some homework to ensure deductions are upheld.